New York Markets After Hours

Treasurys inch down as investors digest Fed move

U.S. plans to sell $98 billion in bonds next week

By

DeborahLevine

NEW YORK (MarketWatch) -- Treasury prices turned lower Thursday, cutting into Wednesday's historic rally, as the Federal Reserve's move to purchase $300 billion in U.S. notes over the next six months rippled through the bond market.

On Wednesday, government bond yields plunged by their widest margin since the 1987 stock market crash. Touching off the rally was the Fed's announcement it plans to buy government notes with maturities of two to 10 years.

The move, which pushed 10-year yields down to the lowest this year, may have prompted some investors to lock in gains.

"We may be close to being done with the rally," said Jeffrey Given, portfolio manager at MFC Global Investments.

Ten-year yields
TMUBMUSD10Y, +0.72%
increased 6 basis points to 2.59%, after falling to 2.45% in earlier trading. A basis point is one hundredth of a percent. Bond prices move inversely to their yields.

It's a small part of the benchmark note's full 50 basis point drop on Wednesday. See story.

Two-year yields
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also gave up earlier declines and headed slightly higher, by 2 basis points to 0.85%. On Wednesday, the yields dropped the most since October.

Fed policy makers also said Wednesday that the U.S. central bank would buy an additional $750 billion of agency mortgage-backed securities, a move intended "to provide greater support to mortgage lending and housing markets."

This brings the total amount of agency mortgage-backed securities purchases to $1.25 trillion. The Fed said it would double its purchase of agency debt, including securities sold by Fannie Mae
FNM, +2.52%
and Freddie Mac
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bringing the total to $200 billion. See more on Fed's plans.

"Everything else was helping on the margin, but it wasn't enough to spur growth," Given said, explaining the Fed's latest move to prop up the U.S. economy.

Primary mortgage rates should fall towards 4.75% during the coming weeks, according to analysts at Barclays Capital. Thirty-year rates are currently about 5%.

Paradoxical impact

Stepping up purchases of mortgage-backed securities may have the effect of helping lower Treasury yields if this were to spark more mortgage refinancing, which forces investors to adjust the duration of their portfolio by buying Treasurys. Duration is a measure of the sensitivity of the price of a fixed-income asset to a change in interest rates, and is partially determined by maturity.

"To the extent Wednesday's rally can provoke lower mortgage lending rates, we can then look to some form of a refi boomlet," said strategists at RBS Greenwich Capital.

The Fed has decided to buy Treasurys "because consumer lending rates have remained sticky at higher levels despite Fed cuts and mortgage purchases," said George Goncalves, chief Treasury and agency-debt strategist at Morgan Stanley. "It is also a safety net to their existing market support schemes that were being used less aggressively than hoped for."

In the near term, 10-year yields may be headed down to retest their lows of 2.06%, he said.

More supply, weak data

Also Thursday, the Treasury announced it plans to auction $40 billion in 2-year notes and $34 billion in 5-year notes
TMUBMUSD05Y, +1.19%
It will also sell $24 billion in 7-year notes, a maturity reinstated last month after a long break to help spread out the government's financing needs.

The sales of the securities will take place next week.

Earlier, Treasurys played off Labor Department data showing initial claims for unemployment benefits declined in the most recent week, though continuing claims increased to a new record -- indicating finding a new job is increasingly difficult. See more on jobless claims.

Notably, Fed officials on Wednesday removed language saying they expected the economy to recover later this year. The latest information only showed further contraction, they said.

"The market appears to be realizing the severity of the situation, but has not yet fully priced it," said T.J. Marta, strategist and founder of research firm Marta on the Markets.

"The realization that any economic recovery will derive solely from persistent governmental fiscal and monetary stimulus is gaining ground, but the situation remains more dire than is generally appreciated."

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